The energy market is a complex beast, its many parts
interconnected through a multitude of linkages. When one part fails, the entire
system reacts: certain linkages are burdened with extra stress, while other
components sit idle. Only by studying the entire machine can one understand
the rippling effects that stem from one change.
With the energy market, the system is made up of various
sectors - oil, natural gas, uranium, coal, and alternative energies - and the
countries that have each of those energy resources. The components are then
linked through a long line of forces, including the geographic distributions
of supply and demand, international allegiances and trade deals, global
markets and commodity prices, and the ever-evolving field of international
relations. A change in any country, sector, or linkage resonates through the
entire system.
From this perspective, North America's shale gas
revolution truly earns its accolade as a "game changer." As many
people now understand, the boom in natural gas reserves and production in the
United States and Canada is changing the way North America will power itself
in the future.
What a lot of people do not understand is how to profit
from this shift.
Natural gas prices are depressed and expected to remain
so for the short to medium term, so investing in natural gas options or a
natural gas exchange-traded fund is not likely to bring home the big bucks
anytime soon. Domestic natural gas equities are an even riskier idea - most
producers are scaling back production and selling assets as they hunker down
in preparation for a tough few years.
In this case, the way to profit is by understanding how
natural gas' changing role is impacting North America's energy machine as a
whole. Cheap natural gas is prompting utilities to switch from coal to gas
where possible. The confluence of cheap natural gas and a risky global
economy has droves of investors turning their backs on green energy, the
sector that was such a market darling only a few years ago. Farther down the
road, North Americans are debating - and in places implementing - a range of
strategies to take advantage of the continent's newfound abundance of natural
gas, from natural-gas-powered transport trucks to exportation of liquefied
natural gas (LNG).
Isaac Newton showed us that for every action there is
an equal and opposite reaction. That is why every downside force in the
energy sector creates upside opportunities elsewhere. The challenge is
finding them. It takes an understanding of the entire global energy machine
to figure out what areas are benefitting from the changing landscape.
For Every Down, There's an Up
Natural gas seems to know that it is heading for
several years in the doldrums and, in fighting spirit,
it is trying to take a couple of other energy sectors down with it.
With coal, it is succeeding, but there are still lots
of coal opportunities outside of the United States. With uranium, the global
supply-demand scenario and America's position within it is in such flux right
now that cheap natural gas is doing little to reduce America's need for U3O8.
Then there's the well-field services sector, where the successes born from horizontal
drilling and fracturing created the gas supply glut that is forcing
production cuts. Far from slowing down, however, well-field service companies
are busier than ever as the oil industry adopts fracking
to access shale oil, and the deepwater Gulf of Mexico continues to test the
limits of drilling technology.
Coal
The sector feeling the worst impacts from gas' downturn
is thermal coal. Demand for the coal burned to generate power in the US is
plummeting as utilities take advantage of the cheapest natural gas in ten
years. Consumption of coal to produce electricity is expected to fall 2% this
year to its lowest level since 1992, while gas-fired consumption rises 5.6%.
Making matters worse, winter heating demand is falling in the face of mild
weather: through January, this has been the warmest winter since 2006 and the
fourth-warmest on record. With natural gas and warm weather conspiring
against it, coal demand is decidedly down - in the second week of February,
coal consumption was 4.3% lower than it was a year ago.
Exports are not going to provide any help. Last year,
Europe bought 50% of America's thermal coal exports, but demand from the EU
is shrinking as the region struggles to stave off a recession. The economies of
the EU shrank 0.3% in the fourth quarter of 2011 compared to the previous
quarter, the first contraction since mid-2009.
In response, US thermal coal prices are deteriorating.
Appalachian coal, the US thermal-coal benchmark, fell 15% in January alone to
sit near US$60 per tonne and has moved little since
(by comparison, Australian thermal coal is currently fetching almost US$120
per tonne). Mining costs to dig thermal coal out of
the ground range from $60 to $75 per tonne for
Central Appalachian producers, which means margins
are already razor thin or nonexistent. Several major US thermal coal
producers are reducing output and in some cases closing mines, including Arch
Coal (NYSE.ACI), Patriot Coal (NYSE.PCX), and Alpha Natural Resources
(NYSE.ANR).
Now for some good news. Thermal coal prices in the
United States may be faltering, but that doesn't mean that coal is in the
doldrums across the globe. In fact, quite the contrary: global thermal-coal
demand is expected to increase by 50% from 2008 to 2035, with the vast
majority of increased demand coming from the developing world. That equates
to a demand increase of 1.5% each year, and production is not quite expected
to keep up to that pace. Rising demand plus not-quite-enough supply equals
investment opportunities - maybe not in the US, but elsewhere.
That's just thermal coal. There's another component to
the coal world: metallurgical coal, the higher-carbon coal used to make
steel. Supplies are even tighter with metallurgical coal, which is why our
subscribers have exposure to "met coal" through either equities or
a fund. More recommendations are on the horizon: the upcoming edition of the Casey
Energy Report will be all about coal. We will provide the background,
supply and demand projections, and the best ways to profit from the global
coal sector.
Uranium
The abundance of cheap gas has utilities looking to
build more gas-fired power plants. Some observers have suggested that this
will be to the detriment of the nuclear sector in the US. But that perspective
is pretty shortsighted.
It is true that some utilities have delayed plans for
new nuclear plants by a few years, primarily in response to the Fukushima
nuclear disaster in Japan and the ensuing public backlash against uranium.
But that backlash is already fading; and those delays will have only a
minimal impact on the nuclear sector in the US. Five new generators are on
track for completion this decade, including two reactors approved just a few
weeks ago (the first new reactor approvals in the US in over 30 years). Those
will add to the 104 reactors that are already in operation around the country
and already produce 20% of the nation's power.
Those reactors will eat up 19,724 tonnes
of U3O8 this year, which represents 29% of global
uranium demand. If that seems like a large amount, it is! The US produces
more nuclear power than any other country on earth, which means it consumes
more uranium that any other nation. However, decades of declining domestic
production have left the US producing only 4% of the world's uranium.
With so little homegrown uranium, the United States has
to import more than 80% of the uranium it needs to fuel its reactors.
Thankfully, for 18 years a deal with Russia has filled that gap. The
"Megatons to Megawatts" agreement, whereby Russia downblends highly enriched uranium from nuclear warheads
to create reactor fuel, has provided the US with a steady, inexpensive source
of uranium since 1993. The problem is that the program is coming to an end
next year.
At present the world is producing just enough uranium
to meet global demand, but this precarious balance is already tipping. There
are dozens of new reactors under construction in China, India, South Korea,
and Russia that will need fuel. Production increases from new mines and mine expansions
are not expected to keep pace. The race to secure uranium resources is on,
and for the first time the US has to compete.
The answer is domestic production. The rocks underneath
the United States hold lots of uranium, enough to make a significant
contribution to the country's uranium needs. The biggest impediment to mining
this resource is public opposition to the nebulous dangers of uranium mining,
but as the Megatons program ends Americans will start to see that the
alternatives to domestic production are decidedly worse: competing against
China, India, and the like for uranium is an expensive and unstable way to
acquire a desperately needed energy resource. In fact, we have been vocal in
predicting a demand-driven boom in US uranium production. We even expect to
see "Made in America" uranium garnering a premium over imported yellowcake, in the same way that in-demand Brent crude oil
earns a premium above oversupplied West Texas Intermediate crude.
We have already recommended a range of investments to
our subscribers to gain exposure to the coming uranium resurgence and, as
with coal, there is more to come: the next edition of the Casey Energy
Opportunities newsletter will focus on uranium, with recommendations to
boot.
Well-Field Services
The techniques used to unlock natural gas from shale
reservoirs - horizontal drilling and well fracturing - worked so well that
they created a supply glut that is altering the global energy scene. That
supply glut is now prompting natural gas producers to cut back on output,
which you might think would be bad news for the well-field service companies
that complete those tasks.
Not to worry: North America is also in the midst of a
crude-oil production boom, and the common theme linking most of the
continent's new wells is highly technical drilling and production methods.
The purveyors of those techniques are the continent's well-field service
companies, and their services are very much in demand.
Well-field service companies have been able to
compensate for lost gas fracking business by
shifting to oil, as the oil industry has adopted fracking
to unlock its shale deposits. If you've read about the oil production boom
that is keeping North Dakota's economy hopping, you read about the Bakken shale formation. In the Bakken,
wells are drilled horizontally to follow along the oil-bearing layer, and
then high-pressure fluids are forced down the well to fracture the shale and
release the oil.
Meanwhile, the challenges of producing oil in the
deepwater Gulf of Mexico continue to test the limits of drilling technology.
Pushing through kilometers of water before drilling through just as much rock
and then extracting and transporting oil from a platform rocked by waves and
threatened by hurricanes demands a wealth of specialized equipment and
operators.
Most oil and gas companies do not own drill rigs, nor
do they actually drill or fracture their own wells. They contract those jobs
out to companies that drill and frac for a living,
known as well-field service companies. And with wells in America's booming
oil and gas fields requiring more complicated and more technical services
with each passing year, the services these companies provide are essential to
North America's oil and gas producers.
The Casey energy team is all over the well-field
services sector. Subscribers to the Casey Energy Report newsletter and
the Casey Energy Confidential alert service were alerted to our latest
recommendation in the sector in mid-November. Three months later, our
investment is already up roughly 50% and we suggested that subscribers take a
"Casey Free Ride," which means selling enough shares to recoup
one's initial investment and retaining the remaining "free" shares
for continued, risk-free upside exposure.
The Take-Home
When a machine is as interconnected as the global
energy trade, no part can change without impacting the rest. The dramatic
debut of shale gas in North America has done far more than just depress
domestic natural-gas prices - a shift of this magnitude has impacts that
reach far beyond one commodity or one country. Some of those impacts are
negative, but hidden in the doom and gloom lie opportunities to profit. The
key is to open your horizons and embrace the complexity and
interconnectedness of the global energy machine... either that, or find a
good mechanic who can do the job for you.
[One of the best opportunities we've seen in years
involves leveraging a touchy situation that OPEC doesn't want you to know
about. Learn more about it.]
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